Out-Law Analysis 5 min. read
15 Jul 2021, 2:37 pm
Mutual societies, including friendly societies, account for £90 billion in revenue and impact one in three UK citizens.
Mutuals carrying out regulated activities in the UK must be authorised to do so by either, or both of, the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) depending on the nature of the regulated activities.
While there has been no meaningful PRA enforcement action against mutuals to date, systems, controls and operational resilience viewed from an environment, social and governance (ESG) or equality, diversity and inclusion (EDI) perspective could be areas that come to the forefront in the future, given the regulators’ current areas of focus. This is particularly the case considering the issuance of the Bank of England’s, FCA’s and PRA’s joint discussion paper on diversity and inclusion in the financial sector in July 2021.
As is the case for other financial products and payments, there is no one piece of legislation which sets out the ESG and EDI framework applicable to mutuals. Instead, there is an ever-increasing series of norms contained in a range of national, international and supranational laws and policies, which are themselves in a state of flux due to the UK’s withdrawal from the EU amongst other factors.
Relevant laws and policies include, but are not limited to:
The PRA recently sought views about how it should go about “strong and simple” prudential regulation in the context of the UK’s departure from the EU. Whilst this concept is restricted to deposit-takers, the ongoing review of Solvency II also seeks to make the capital regime for UK insurers more proportionate.
Senior Associate, Pinsent Masons
Mutuals often serve more people and have more members that have protected characteristics as defined by the Equality Act than other financial institutions
The PRA has said that its new regime will include “new requirements to ‘have regard’ to issues like international standards, equivalence, the relative standing of the UK to do business, as well as climate change and productive finance”. It is expecting “more focus on these by external stakeholders”, and is “committed to paying due attention to these factors as we carry out our activities”.
Under the 2000 Financial Services and Markets Act (FSMA), the PRA and FCA are obliged to consider the impact on mutuals when consulting on changes to their rules.
For mutuals, navigating this framework from a prudential perspective is a matter of interpretation and the application of these norms.
Mutuals may wish to keep in mind how the PRA goes about its decision-making and the factors that it is obliged to consider as a matter of law. The PRA is a creature of public law, and its decisions and approach to regulation must be reasonable and rational. It must take relevant considerations into account as part of its decision-making and discount irrelevant considerations. The intersection between safety and soundness and financial stability on the one hand, and ESG and EDI criteria on the other, is increasingly becoming a relevant consideration.
Mutuals often serve more people and have more members that have protected characteristics as defined by the EA 2010 than other financial institutions – i.e. age; disability; gender reassignment; marriage and civil partnership; pregnancy and maternity; race; religion or belief; and sex. It follows that the acts and omissions of mutuals can have significant impacts on vulnerable demographics which may have financial stability impacts, as well as ramifications for the safety and soundness of the mutual in question. For example, if a mutual took a decision about a regulated financial product that detrimentally impacted women across the UK, this would have a financial stability impact and a regulator may be interested in the systems, controls and governance that led to such a decision being taken. Having a committee that considers the ESG and EDI impacts of decisions, particularly in relation to the design, distribution of and access to regulated products relevant to overarching financial stability, could be one way of minimising risk here.
They may also wish to consider to whom and how prudential requirements will be applied in the context of ESG and EDI. Prudential regulation tends to focus on those mutuals of greater systemic importance that can directly impact financial stability as opposed to those of a smaller scale, and this is equally the case for ESG and EDI considerations. However, where smaller firms on aggregate have an impact on financial stability, this is also likely to attract the regulator’s attention, as reflected in the latest iteration of the PRA’s supervisory policy documents (40-page / 1MB PDF).
Statements about priorities in the ESG and EDI context will inform how the legal framework is applied to mutuals. To date, the FCA has been more vocal than the PRA about the “social” element of ESG insofar as it touches on EDI – for example, FCA chief executive Nikhil Rathi gave a speech in March 2021 about why diversity and inclusion are regulatory issues. The PRA also made a statement about diversity on boards (2-page / 168KB PDF) in March 2020, reminding firms of the importance it places on diversity for improving decision-making and providing effective challenge. More recently, there is also the PRA/FCA/Bank of England joint discussion paper referred to above. It is always worthwhile keeping a close eye on what is said in industry speeches and parliamentary select committees for an indication of the future direction of travel.
To date, the only regulatory actions against financial institutions in this space have been the cancellation of permissions of Lower Inveagh Credit Union (in Liquidation) and Spa Credit Union Limited in 2014 and 2016 respectively. That said, there are still lessons to be learned from enforcement against other firms and public policy statements which may be of relevance to mutuals.
In July 2019, Miles Bake, the PRA’s head of legal, enforcement and litigation division, said that the PRA’s cases have tended to fall into two broad categories (9-page/ 404KB): where conduct by a firm or an individual could impair the PRA’s ability to supervise properly, or represents behaviour outside the bounds of what the PRA considers acceptable; and where there has been a crystalised ‘risk’, action or public event which could have a direct impact on the PRA’s statutory objectives. Bake also explained the PRA’s enforcement objectives stem from its broader strategic aims.
Operational resilience is one of the PRA’s strategic priorities for 2020-21, and has been for some time. For mutuals, which have been required to hold members’ meetings and offer services online to a degree not previously seen during the Covid-19 pandemic, operational resilience will be of increasing relevance, at least in the near future.
From an ESG/EDI perspective, enforcement could be justified where an IT or other operational failing meant that members could not participate in decision making or people could not access services, and where there was disproportionate impact on those with certain protected characteristics. For example, older people may sometimes struggle to access online services.